Innovative Ideas in Currency Management October 2005

2 Evolution of Currency Management Currency mandates –Hedging (late 1980s; mid 1990s); Pure alpha (late 1990s; current) –Absolute return (early 2000s) –Cash play – use innovative FX programs to fill cash flow gap Currency managers –Single style using only forwards in EAFE markets (to late 1990s) –Multi-style using forwards, options, developed and emerging Currency clients –Passive benchmark to managing their own strategic currency risk

3 Philosophy: An Untapped Alpha Opportunity! Corporate Treasurers (Insure foreign profits) Central Banks (Increase employment, lower inflation) International Bond and Equity Managers (Need to buy currency to buy foreign assets) Currency Market Many participants have non-profit motives Individuals(Tourism)

4 Impact of Diversification – Opportunities and Markets Developed Markets Add Options (Developed) Add Emerging Markets All Three Number of Transactions Maximum 10 Additional 20 Additional 20 Currencies Average 40 Net Return (for 12% volatility) 7%10%17% Return/Risk Ratio 0.5 – – – Cannot use overlay models/approach in this absolute return paradigm

5 Market Inefficiency = Simple Rules Make Money Three simple rules make money in currencies. 1. Currency markets trend.  Buy the currency that went up last month. 2. Currencies with high interest rates will appreciate vs. currencies with low interest rates.  Buy high interest rate currencies. 3.Options tend to be overpriced.  Sell options.

6 Performance of JPY Rules/Strategies Rules Evaluated: (a) yield curve; (b) carry; (c) moving average USD/JPY Strategy = 40% Yield curve and Carry, 20% MA Diversification improves information ratio, skill, & drawdown Strategy/ Rules Annualized Return Annualized Std Deviation Information Ratio Cumulative Return Confidence in Skill Success Ratio Ratio Good /Bad Risk Max Drawdown USD/JPY Strategy 4.59%8.56% %94.17%52.86% % USD/JPY Yield Curve 4.54%11.59% %85.59%53.43% % USD/JPY Carry 4.33%11.59% %84.26%52.37% % USD/JPY MA %11.59% %79.05%51.12% % Source: AlphaEngine TM, Mcube Investment Technologies, LLC (purely hypothetical example for educational purpose only)

7 Performance of EUR Rules/Strategies Rules Evaluated: (a) yield curve; (b) carry; (c) moving average USD/EUR Strategy = 40% Yield curve and Carry, 20% MA Trend model losses are meaningful; but moderate lower drawdown and worst single performance of the strategy Strategy/ Rules Annualized Return Annualized Std Deviation Information Ratio Cumulative Return Confidence in Skill Success Ratio Ratio Good /Bad Risk Max Drawdown USD/EUR Strategy 3.79%5.09% %98.89%55.21% % USD/EUR Yield Curve 5.20%6.26% %98.42%82.95% % USD/EUR Carry 8.48%9.71% %99.56%55.21% % USD/EUR MA %9.72% %3.13%46.68% % Source: AlphaEngine TM, Mcube Investment Technologies, LLC (purely hypothetical example for educational purpose only)

8 Return calculated versus a 0% hedged position Do Nothing Partially Hedge Fully Hedge % of Exposure Hedged Growth of a dollar from hedges

9 Innovative Approaches for Clients Can generate meaningful cash, without funding, and with a specific dollar loss limit (easiest constraint to monitor) Can be delivered through a managed account or even total return swap Clients can also manage their own strategic decisions – biggest impact on performance Trend to move away from traditional approaches and markets